SOLUTN (0093) SOLUTION ENGINEERING HOLDINGS - Solution for Education (F)
In previous post,
we explored the business model of SOLUTN. In this post, we will look at
SOLUTN (0093) financial numbers to understand more about its company
financial and its business performance from income statement, balance
sheet, and cash flow statement. Finally, we will do a valuation to
determine if the current price is a good bargain. To begin, we
always believe that
“In the business world, the rear-view mirror is always clearer than the windshield. - Warren Buffett”, so while doing our research, we prefer to start by looking at the past performance of the company over the years.
Income Statement
The
basic requirement of a good business is to make money. So how did
Solutn perform for the past 5 years? From the past record, the business
performance of the company was not impressive before FY13. Anyone who
invested in the company before FY13, must have strong faith in the
management. So what has happened to the company in FY11-FY12?
In
FY11, the company has posted 11.3 mil Revenue (-38% YoY) and 0.4 mil
net profit (-81% YoY) due to "lower sales of SOLEQ equipment projects
recognised and also lower profit margin in certain R&D projects -
Annual Report 2011”. Apart from that, in the FY11 Q4 quarterly report,
it was clearly stated that the company has unusual high Administration
and Distribution cost, because of provision of RM 300,000 for fire
damage, which was an one-off loss.
Taken from Solution FY11 Q4 financial report
In
FY12, the company’s financial performance continued to drop by posting a
revenue of 7.9 mil (-31% YoY) and making a net loss of -2.1mil. The
management put their blame of the disappointing performance on
competitive business environment and reduced government budget. Another
reason was due to the write off of subsidiary development expenditure
that was about 2 mil.
Taken from FY12 Q4 financial report
Taken from FY12 Annual Report
Though
there were some one-off items during this difficult period, we do think
that these are acceptable, while 300k fire damage provision was
insignificant too. High percentage of Administration and Distribution
costs during low revenue period are the real culprits that caused loss
to the company. In FY11, the admin and distribution costs was about 28%
of the revenue, while in FY12, it surged up to 52% after excluding the 2
mil write off expenses, mainly due to the lower revenue in the year,
which led to EBIT (Earning Before Interest and Tax) of -2.1 mil. We
believed the management was aware of this during that time, and has been
working hard to be more cost-effective and productive in operating
their business. The company has started to turnaround its business in
FY13, where its EBIT has seen to improve slightly to 0.74 mil net
profit. This was mainly due to effective cost control in project
contracts by the management and also sales of a new product development.
As
a result of the management’s effort in improving sales of their
equipment segment and venture into various businesses (biotech,
automation), the company has now recorded 34.5 mil sales, resulting with
7.1 mil net profit and achieving impressive net profit margin of 20.7%
in FY16 Q3 (TTM). In overall, the company has given impressive growth of
25% CAGR on its revenue and 78.5% CAGR on its net profit over the past 5
years.
Illustration 1 - Profitability data from FY11 - FY16 Q3 (TTM)
Illustration 2 - Profitability from FY11 - FY16 Q3 (TTM)
Illustration 3 - Profit Margin from FY11 to FY16 Q3 (TTM)
Considering volatility
of MYR in recent years, one would like to know if the company’s
main revenue is from domestic or foreign market. Illustration 3 shows
that the main revenue contribution is predominantly from domestic market
(93%) and 7% from overseas in the latest FY16 Q3 (TTM). The company has
shown significant sales growth in domestic market, while overseas
market remains flat.
Illustration 4 - Segmental revenue from FY11 - FY16 Q3 (TTM)
Illustration 5 - Geographical distribution of Revenue in FY16 Q3 (TTM)
As
mentioned previously, majority of the sales is from contract based
works and projects, which are non-recurring. In FY15, the contract based
revenue has contributed 99% of the total revenue, worth 28.7mil, while
only 1% came from the sales of goods. Illustration 6 shows that the
contract revenue has grown significantly over the years. However, the
management only mentioned that they are backed with strong order book
without providing actual figure for it. Due to its business nature, we
think it is important for the company to reveal their current order book
to the public, to figure out the sustainability of their business.
Despite of the lack of information, the financial number tells us that
the current performance company is impressive.
Illustration 6 - Sources of Revenue from FY11 - FY15
Balance Sheet
Now,
let us dive into the balance sheet to see how’s the financial health of
the company. As an investor, the last thing we would like to do is
investing in company that is facing financial difficulty and near to
bankruptcy any soon, as this will expose ourselves to high risk. We
prefer company with no/low debt, net cash, good liquidity ratios
(current ratio, quick ratio, cash ratio).
Illustration 7 - Liquidity ratios
Illustration 8 - Key data extracted from Balance Sheet
From
the figures, we find how amazing that SOLUTN is able to keep their
healthy balance sheet over the years despite of those tough sales years.
From Illustration 8, we can see that the management has been keeping
their debts low to avoid the double edge effect of the leverage in their
business. One notable highlight is their cash & securities have
been growing from 8.4 mil (FY11) to 19.8 mil (FY16 Q3), which represents
a CAGR of 20% over 5 years period. This indicates that real cash AKA
Free Cash Flow (FCF) is generating from their operation. Having
relatively huge pile of cash in hand, the company is currently a net
cash company. All liquidity ratios such as current ratio, quick ratio,
and cash ratio, have been at healthy level, which tell us that the
company will not face any financial issue with this strong balance
sheet. One might ask, why is the cash per share has dropped to 6 cents
per share in FY16 Q3, this is due to dilution from 1:2 bonus issue last
year. In overall, we are happy with the balance sheet of the company as
it lowers the investment risks.
Cash Flow Statement
Cash
flow is like the blood circulation system of a company. A healthy
business should be able to generate cash from its operation after
spending on necessary CAPEX. We prefer company that has shown consistent
CFFO (Cash Flow From Operation) with low CAPEX (Capital Expenditures),
which leads to positive FCF (Free Cash Flow). Regardless of the
profitability, the objective is to generate real cash from the business
operation alone, which shows how important it is to look at the
CFFO. Low CAPEX may indicate that the business is not capital intensive
and its easier to manage with low capital requirement. Company that
has positive FCF will show increasing cash in hand, which can be used
for dividend payout to reward its shareholders or spend on acquisition
new PPE or businesses. In the case of SOLUTN, we see
inconsistent CFFO over the past 5 years. However, one thing that we can
observe from the past is that the business is not capital intensive as
shown by the consistently low CAPEX in the past. We hope to see more
consistent cash flow from the company in the future.
Illustration 9 - CFFO, CAPEX and FCF
Illustration 10 - Cash Flow Checklists
Based on our own cash flow checklists, we rate the cash flow condition of SOLUTN as AVERAGE.
Management
It
is undeniable that good management is a plus to both the company and
investors. However, evaluation of the management is mostly requires
qualitative and subjective. Nevertheless, there are few quantitative
metrics that can provide some information about the efficiency of the
management. We will be looking at the ROE (Return on Equity), ROIC
(Return on Invested Capital), CROIC (Cash Return on Invested Capital)
and ROA (Return on Assets).
Illustration 11 - Efficiency ratios from FY11 to FY16 Q3
From
Illustration 9, 3 of the efficiency ratios, ROE, ROIC, and ROA have
been increasing consistently annually after the terrible FY12. This is a
good sign that showing that the company is being well managed,
especially in latest FY16 Q3, the company has recorded 18% ROE, 41% ROIC
and 15% ROA. High ROIC as such tells us that the company might have
certain level of competitive advantage in the industry.
ROE
can tell us how efficient is the management in generating profit for
the shareholders, but it can be easily distorted by financial leverage.
Hence, we would like to breakdown ROE into 3 components: Financial
Leverage, Asset Turnover, and Net profit margin. We can see from
Illustration 10 that the improving ROE is mainly attribute to higher
asset turnover and improvement in net profit margin, which is desirable.
Illustration 12 - DuPont Analysis
ROA
tells us how much profit the company has made for every dollar of its
assets. The past ROA tells us that the company has been
consistently improving its utilization of assets over the years, which
is a good sign. Finally, it comes to the CROIC of the company. Its CROIC
is inconsistent and fluctuated over the past years, this is due to
inconsistent CFFO (Cash Flow From Operation) especially in FY15. This
was caused by huge reduction in trade payables. We hope to see more
stable and consistent CROIC from the company. After all, we would like
to remind our readers that these metrics would be more useful to compare
against peers, which we couldn’t identify any at the moment.
Valuation
Till
the end of the day, a good investment is pretty much depending on the
price versus value of the company. We prefer to invest with
sufficient Margin of Safety to lower the downside of an investment.
There are various valuation tools that can be used to value the company.
First of all, we used some of the common relative valuation metrics
to have a quick check on the current valuation based on the
latest closing price at 0.340 on 10/02/2017.
Illustration 13 - Common Relative Valuation metrics
From
Illustration 13, the relative valuation metrics show that the
current price does not seem to be attractive. Please note that the
metrics are compared against general benchmark as a reference. We think
the company is currently at fast growth stage, hence, we may attempt a
valuation based on PEG ratio, that is popularized by the legendary fund
manager, Peter Lynch.
Illustration 14 - PEG valuation
In Peter Lynch’s book "One Up On Wall Street”,
he mentioned that a PE ratio that is half of the growth rate is a
bargain, PE that is equal to the growth rate is fairly priced, while PE
that is double of growth rate is overly priced. In this case, we will
try to check on the PEG based on different growth assumptions. We found
that based on the 5-year CAGR at 78.5%, the PEG is only 0.18, which is
undervalued. However, based on lack of information revealed by the
management about the future growth, we think it is over-optimistic to
think that the company is able to sustain their growth at 78.5% without
the support of strong evidence or details, thus, this is known as the BEST case. In BASEcase
scenario, we applied a reverse engineering from 0.5 PEG, we found that
the current price is undervalued if the company is able to keep its
earning growth at 29%. In WORST case, if the company’s earning growth is at 15%, the current price is fairly valued by the market.
Conclusion
To
conclude this financial post, we find SOLUTN to be a company with good
fundamental, which has low likelihood of facing any financial issue in
near term, which further backed by its net cash position. In term of
profitability, the company has shown remarkable net profit growth at
78.5% CAGR, which mainly contributed from domestic market. However, the
cash flow of the company has not been consistent over the past 5
years. Apart from that, various efficiency ratios have also shown that
the capability of the management in improving its operation efficiency
and productivity. Finally, based on the PEG valuation approach, the
company appears to be undervalued, but given the lack of information
disclosed by the management, we do not like to be overly optimistic in
their future growth, we would like to have clearer evidence to conclude
the current valuation of the company.
By the time of writing, we are not vested in SOLUTN.
SOLUTN (0093) SOLUTION ENGINEERING HOLDINGS - Solution for Education (F)
http://klse.i3investor.com/blogs/stockify/115652.jsp
